The Role of Financial Institutions in Long Run Economic Growth By Michael W.

Brandl The University of Texas at Austin McCombs School of Business Department of Finance The recent economic difficulties in Southeast Asian economies are often linked to the financial sector in these countries. The business and popular press around the world are replete with stories connecting the economic crisis with difficulties in the financial sectors in these economies. The connection between the troubled banking sector and the economic slowdown is especially stressed. Asian economies that have been less impacted by the economic crisis, for example Taiwan, are often characterized as having more stable financial institutions then their neighbors. Yet this is not the first time financial difficulties have been linked with poor macroeconomic performance. Many today believe the Great Depression of the 1930s was made much more sever by problems in the banking sector specifically and financial markets inefficiencies in general. More recently the dramatic economic slowdown in the 1980s in the state of Texas in the United States are often linked to the banking and savings and loan crisis that gripped the state at the same time. This raises the question, what is the link between financial institutions and the macroeconomic performance of an economy? Economists hold dramatically different views regarding this question. From a much earlier time, Bagehot (1873), and Schumpeter (1911) argued that an efficient financial system greatly helped a nations economy to grow. As Ross Levine has pointed out it was Schumpeters contention that well-functioning banks spurred technological innovation by offering funding to entrepreneurs that have the best chances of successfully implementing innovative products and production processes. More recent economists have more skeptical about the role of the financial sector in economic growth. Joan Robinson (1952) asserted that economic growth creates (emphasis added) demand for financial instruments and that where enterprise leads finance follows. Robert Lucas (1988) has also dismissed the finance-economic growth relationship stating that economists badly over-stress the role financial factors play in economic growth. However in recent years thanks to the work of Ross Levine (1997, 1998), Robert King (King and Levine 1993a, 1993b, 1993c) and others (Pagano 1993), economists are again reexamining the role financial markets play in economic growth. On the theoretical side complex models have been developed to illustrate the many channels through which the

development of financial markets affect and are affected by economic growth. These channels include the facilitation of trading hedging, diversifying, and pooling of risk; the efficient allocation of resources; the monitoring of managers and exerting corporate control; the mobilization of savings; and the facilitation of the exchange of goods and services. On the empirical side a growing body of studies at the firm-level, industry-level, countrylevel and cross-country comparisons have demonstrated the strong link between the financial sector and economic growth. King and Levines (1993a, 1993b, and 1993c) research has shown that level of financial depth (defined as the ratio of liquid assets to GDP) does in fact help to predict economic growth. Other work by Levine (1997, 1998) has shown that financial intermediary development does positively influence economic growth, these results are shown to be robust, that is the relationships still hold when other factors that are know to influence economic growth are held constant. In many ways the current research has opened as many new questions as it has attempted to answer. On the theoretical side, questions still exist on how and why do financial markets and institutions evolve? Why are financial markets at different levels of development in different markets? This research has also raised a number of very interesting public policy questions. Such as: under what legal environment do financial institutions development more rapidly? Financial regulation -- how are countries financial systems regulated and supervised, how can these be quantified, and to what extent do the differences matter. What is role of regulation in encouraging financial market development? What impacts both positive and negative will the recent bailout of financial institutions and financial markets have on the long run development of financial markets? I would like to turn our attention to one of these issues that I find most intriguing: why do financial markets develop at different rates in different economies? That is, why do financial institutions tend to cluster in high-income areas or economies and low-income areas seem to suffer from a lack of financial institutions? A related question is; do financial markets drive economic growth or does economic growth drive the creation of financial market and institutions? Why do financial markets develop at different rates? My idea centers on the concept of a poverty trap in the provision of financial instruments and in the development of financial institutions. One illustration of a poverty trap is the trap an economy can find itself in terms of human capital development, if learning has positive spillovers. Let us look at an example of how a poverty trap in human capital works. We will start with a counter example. That is, first let us look at how human capital has a positive spillover effect.

Let us suppose that knowledge and learning have positive spillover effects in casual conversations. That is, if members of our society invest in human capital attainment by reading, learning, studying, etc., then there will be a sharing of this knowledge in casual conversation. Thus, I will learn from you and you will learn from me in our casual conversations. Therefore there will be a positive incentive for me to invest in human capital attainment since that will allow me to gain more from (and contribute more to) our conversations. Likewise, you will have an incentive to invest in your level of human capital as well. Thus, throughout the entire economy there will be incentives for people to invest in their human capital attainment, and thus the societal level of human capital will increase. The result is that we have: High levels of human capital incentive to invest in more human capital due to positive spillovers high levels of human capital investment high levels of human capital. This positive re-enforcement mechanism can, however work in reverse, thus creating a trap. If a society has low levels of human capital attainment, the positive spillovers will be negligible; thus the incentives for further human capital attainment will be low. Due to a lack of incentives human capital investment will be low resulting in a continued low level of human capital for the society. However since human capital is an important determinant of economic growth, this society with low levels of human capital will also suffer slow or no economic growth thus being trapped in a cycle of poverty. My contention is that, perhaps, financial sector development functions much the same way that human capital attainment functions. A lack of financial institutions in an economy will make it very difficult for people to save. One argument that is often heard when one discusses the lack of financial institutions in economically repressed areas is that, people in low-income areas simply do not save. This it is argued is why there is a lack of financial institutions. I argue that the causation runs the other way. People in poorer areas do not save at high levels due to a lack of financial institutions. In fact it can be argued that people in economically disadvantaged areas do save. They simply do not save via financial institutions. It is well known among social workers in the United States for example, that low income families do save portions of their public assistance funds, even though for many years it has been illegal for them to do so. This savings usually takes the form of literally saving money in a cookie jar or under a mattress. This preponderance to hold cash may also explain the high incidence of home break-ins in economically disadvantaged area. The implications, however, are clear; the poor do save but not in financial institutions. These low savings in turn makes it difficult for entrepreneurs in the economy to borrow funds in economically disadvantaged areas. Due to this difficulty in borrowing experienced by entrepreneurs the economy will experience a low level of investment. Thus, even though savings is taking place in the economy, the savings is not being used efficiently since it is not making its way into the hands of deficit units. If the savings

could make their way to the entrepreneur the resulting investment would have positive spillover effects for the entire economy. The positive spillover effects from investment to economic growth are well known. If investment in physical capital creates new knowledge, then as Romer (1986, 1987) has shown there will be a spillover from each persons investments to knowledge that is useful for all the other agents in the economy. Economies that already have high capital will have the highest returns for new investment. Higher levels of investment led to positive spillovers increasing the returns to and incentives for higher levels of investment. However, in economically disadvantaged areas with a lack of financial institutions a low level of investment results due to the lack of incentive for investment. This low level of investment results in slower or no economic growth thus retarding the growth of financial institutions in the economy. This relationship can be shown using Figure 1 below. An economy that begins with a lack of financial institutions will thus suffer from a low savings rate. This low savings rate will lead to a low level of investment. Finally, this low level investment will result in slow or no economic growth, further retarding the growth of financial institutions. Then the pattern repeats its self.

Lack of Financial Institutions

Low Savings

Slow or No Growth

Low Business Investment

Figure 1

There also may be other poverty traps stemming for the lack of financial institutions. Consider the role of information costs. With a lack of financial institutions, the information costs for savers and borrows are extremely high. Thus, these high information costs may also be reducing the level of business investment and furthering slowing economic growth. Figure 2 shows this compounding effect from suffering from a lack of financial institutions. The lack of financial institutions result in a low savings rate, but also in increased information costs. Both the low savings and high information costs reduce overall levels of business investment. This lower level of investment slows any economic growth that the economically disadvantaged economy may be experiencing. As in figure 1 the slower economic growth retards expansion of financial institutions and thus the cycle starts over.

Lack of Financial Institutions

Higher information costs

Low Savings

Slow or No Growth

Low Business Investment Figure 2 Under this scenario the lack of financial institutions in an economy creates a poverty trap. In this model the deficit of financial institutions leads to the low official savings

rates, which in turn lead to low levels of investment, further slowing the economy and resulting in a low level of financial institutions. This negative impact is compounded by the fact that the lack of financial institutions increases information costs further slowing business investment. The compounded impact is to further slow economic growth and still further slow the advancement of financial institutions into the market. This method of modeling financial institution impact on the macroeconomy offers an insight into the financial institutions-economic growth relationship. Do financial institutions drive economic growth or does economic growth drive the creation and expansion of financial institutions? The answer is yes to both. The next step in this line of research will be to develop this model formally, perhaps with in an endogenous growth model framework. The model also suggests the need for further study into the savings levels of economic agents in economically disadvantaged areas. Due to illegality of their savings official savings data will not provide effective insight. Conclusion

To review, we have looked at the relationship between institutions and long run economic growth. This growing field of research may offer us a new insight into the dynamics of economic growth within and among various economies. In my presentation here today I have tried to motivate a new approach to modeling the role of financial institutions in long run economic growth by suggesting a poverty trap may exist in economies with low levels of financial institutions.

Bibliography

Bagehot, Walter (1873), Lombard Street. Homewood, IL: Richard D. Irwin, 1962 edition. King, Robert E. and Levine, Ross (1993a), Financial Intermediation and Economic Development. in Financial Intermediation in the Construction of Europe. Editors: Colin Mayer and Xavier Vives. London: Centre for Economic Policy and Research, pp. 156-89. King, Robert E. and Levine, Ross (1993b), Finance and Growth: Schumpeter Might Be Right, Quarterly Journal of Economics, 108(3), pp. 717-37. King, Robert E. and Levine, Ross (1993c), Finance, Entrepreneurship, and Growth: Theory and Evidence. Journal of Monetary Economics, December, 32(3), pp. 513-42. Levine, Ross (1997), Financial Development and Economic Growth. Journal of Economic Literature, 35(2), pp. 688-726. Levine, Ross (1998), The Legal Environment, Banks, and Long-Run Economic Growth. University of Virginia, January, mimeo. Lucas, Robert E. Jr. (1988), "On the Mechanics of Economic Development," Journal of Monetary Economics, 22(1), pp. 3-42. Pagano, Marco (1993), Financial Markets and Growth: An Overview. European Economic Review, 37, pp. 613-22. Robinson, Joan (1952), The Generalization of the General Theory, in The Rate of Interest, and Other Essays. London: Macmillan, pp. 67-142. Schumpeter, Joseph A. (1912), Theorie der Wirtshaftlichen Entwicklung (The Theory of Economic Development). Leipzig: Ducker and Humblot. Translated by Redvers Opie. Cambridge, MA: Harvard University Press, 1934.

Reliance Industries Limited (BSE: 500325, LSE: RIGD) is India's largest private sector conglomerate company by market value, with an annual turnover of US$ 44.6 billion and profit of US$ 3.6 billion for the fiscal year ending in March 2010 making it one of India's private sector companies, being ranked at 264th position in the Fortune Global 500 (2009[3]) and at the 126th position in the Forbes Global 2000 list (2010).[4] Reliance was founded by the Indian industrialist Dhirubhai Ambani in 1966. Ambani has been a pioneer in introducing financial instruments like fully convertible debentures to the Indian stock markets. Ambani was one of the first entrepreneurs to draw retail investors to the stock markets. Critics allege that the rise of Reliance Industries to the top slot in terms of market capitalization is largely due to Dhirubhai's ability to manipulate the levers of a controlled economy to his advantage. Though the company's oil-related operations form the core of its business, it has diversified its operations in recent years. After severe differences between the founder's two sons, Mukesh Ambani and Anil Ambani, the group was divided between them in 2006. In September 2008, Reliance Industries was the only Indian firm featured in the Forbes's list of "world's 100 most respected companies".

Hours of operation
Session Beginning of the Day Session Trading Session Position Transfer Session Closing Session Option Exercise Session Margin Session Query Session End of Day Session Timing 8:00 - 9:00 9:00 - 15:30 15:30 - 15:50 15:50 - 16:05 16:05 - 16:35 16:35 - 16:50 16:50 - 17:35 17:30

The hours of operation for the BSE quoted above are stated in terms of the local time (i.e. GMT +5:30) in Mumbai (Bombay), India. BSE's normal trading sessions are on all days of the week except Saturdays, Sundays and holidays declared by the Exchange in advance.[4]

[edit] History

Bombay Stock Exchange The Bombay Stock Exchange is the oldest exchange in Asia. It traces its history to the 1850s, when 4 Gujarati and 1 Parsi stockbroker would gather under banyan trees in front of Mumbai's Town Hall. The location of these meetings changed many times, as the number of brokers constantly increased. The group eventually moved to Dalal Street in 1874 and in 1875 became an official organization known as 'The Native Share & Stock Brokers Association'. In 1956, the BSE became the first stock exchange to be recognized by the Indian Government under the Securities Contracts Regulation Act. The Bombay Stock Exchange developed the BSE Sensex in 1986, giving the BSE a means to measure overall performance of the exchange. In 2000 the BSE used this index to open its derivatives market, trading Sensex futures contracts. The development of Sensex options along with equity derivatives followed in 2001 and 2002, expanding the BSE's trading platform. Historically an open outcry floor trading exchange, the Bombay Stock Exchange switched to an electronic trading system in 1995. It took the exchange only fifty days to make this transition. This automated, screen-based trading platform called BSE On-line trading (BOLT) currently has a capacity of 80 lakh orders per day. The BSE has also introduced the world's first centralized exchange-based internet trading system, BSEWEBx.co.in to enable investors anywhere in the world to trade on the BSE platform.

BSE indices

Bombay Stock Exchange For the premier stock exchange that pioneered the securities transaction business in India, over a century of experience is a proud achievement. A lot has changed since 1875 when 318 persons by paying a then princely amount of Re. 1, became members of what today is called Bombay Stock Exchange Limited (BSE). Over the decades, the stock market in the country has passed through good and bad periods. The journey in the 20th century has not been an easy one. Till the decade of eighties, there was no measure or scale that could precisely measure the various ups and downs in the Indian stock market. BSE, in 1986, came out with a Stock Index-SENSEXthat subsequently became the barometer of the Indian stock market. The launch of SENSEX in 1986 was later followed up in January 1989 by introduction of BSE National Index (Base: 1983-84 = 100). It comprised 100 stocks listed at five major stock exchanges in India - Mumbai, Calcutta, Delhi, Ahmedabad and Madras. The BSE National Index was renamed BSE-100 Index from October 14, 1996 and since then, it is being calculated taking into consideration only the prices of stocks listed at BSE. BSE launched the dollar-linked version of BSE-100 index on May 22, 2006. With a view to provide a better representation of the increasing number of listed companies, larger market capitalization and the new industry sectors, BSE launched on 27th May, 1994 two new index series viz., the 'BSE-200' and the 'DOLLEX-200'. Since then, BSE has come a long way in attuning itself to the varied needs of investors and market participants. In order to fulfill the need for still broader, segment-specific and

sector-specific indices, BSE has continuously been increasing the range of its indices. BSE-500 Index and 5 sectoral indices were launched in 1999. In 2001, BSE launched BSE-PSU Index, DOLLEX-30 and the country's first free-float based index - the BSE TECk Index. Over the years, BSE shifted all its indices to the free-float methodology (except BSE-PSU index). BSE disseminates information on the Price-Earnings Ratio, the Price to Book Value Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices. The values of all BSE indices are updated on real time basis during market hours and displayed through the BOLT system, BSE website and news wire agencies. All BSE Indices are reviewed periodically by the BSE Index Committee. This Committee which comprises eminent independent finance professionals frames the broad policy guidelines for the development and maintenance of all BSE indices. The BSE Index Cell carries out the day-to-day maintenance of all indices and conducts research on development of new indices. BSE Sensex The BSE Sensex is a value-weighted index composed of 30 companies with the base April 1979 = 100. It has grown by more than four times from January 1990 till date.The set of companies in the index is essentially fixed. These companies account for around one-fifth of the market capitalization of the BSE. We can use information from April 1979 onwards in estimating the long-run rate of return on the BSE Sensex and that comes to 0.52% per week (continuously compounded) with a standard deviation of 3.67%. This translates to 27% per annum, which translates to roughly 18% per annum after compensating for inflation.

Bombay Stock Exchange

The Bombay Stock Exchange is the oldest Stock Exchange in Asia located in Dalal Street , Mumbai in India. Evolution of the Bombay Stock Exchange and its Size The Bombay Stock Exchange was established in 1875 as the Native Share and Stock Brokers Association in 1875. It earned a formal status under the Securities and Exchange Board of India ( SEBI) in 1956. Market Capitalization of the BSE was about Rs 33.4 trillion as on 2006 , October. The Bombay Stock Exchange uses the Bombay Stock Exchange Sensex as the market index in Asia and India. The Bombay Stock Exchange deals with trading in derivatives, equity and other debt instruments . Derivative Market

the Bombay Stock Exchange introduces the first Exchange Traded Index Derivative Contract in 2000. the Index Options started to be traded from 2001 whereas the single stock futures were traded from 2002. The weekly options were introduced in 2004. Index Futures: I ndex futures are basically futures whose underlying asset is the BSE index itself. No commodity or stock constitute the underlying asset.
Index options

The index options like any option gives the holder the right but not the obligation to buy or sell the underlying asset at the specified date and price. Then underlying asset in the case of the index option is again the BSE index itself. Stock Futures and Options Stock futures and the stock options have the normal characteristics as any other stock future or option traded by any index where the underlying asset is some stock. Equity futures and options The equity futures and options that were introduces by the Bombay Stock Exchange have a maximum expiry period of 3 months. Weekly options The weekly options are similar to the monthly options except for the fact that these options are introduced on every Monday of each week and the option matures in a two weeks time.

National Stock Exchange of India

The National Stock Exchange (NSE) (Hindi: ) is a stock exchange located at Mumbai, India. It is the largest stock exchange in India in terms of daily turnover and number of trades, for both equities and derivative trading.[1]. NSE has a market capitalization of around Rs 47,01,923 crore (7 August 2009) and is expected to become the biggest stock exchange in India in terms of market capitalization by 2009 end.[2] Though a number of other exchanges exist, NSE and the Bombay Stock Exchange are the two most significant stock exchanges in India, and between them are responsible for the vast majority of share transactions. The NSE's key index is the S&P CNX Nifty, known as the NSE NIFTY (National Stock Exchange Fifty), an index of fifty major stocks weighted by market capitalisation. NSE is mutually-owned by a set of leading financial institutions, banks, insurance companies and other financial intermediaries in India but its ownership and management

operate as separate entities[3]. There are at least 2 foreign investors NYSE Euronext and Goldman Sachs who have taken a stake in the NSE.[4] As of 2006, the NSE VSAT terminals, 2799 in total, cover more than 1500 cities across India [5]. In October 2007, the equity market capitalization of the companies listed on the NSE was US$ 1.46 trillion, making it the second largest stock exchange in South Asia. NSE is the third largest Stock Exchange in the world in terms of the number of trades in equities.[6] It is the second fastest growing stock exchange in the world with a recorded growth of 16.6%.

Origins

NSE building at BKC, Mumbai The National Stock Exchange of India was promoted by leading Financial institutions at the behest of the Government of India, and was incorporated in November 1992 as a taxpaying company. In April 1993, it was recognized as a stock exchange under the Securities Contracts (Regulation) Act, 1956. NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. The Capital market (Equities) segment of the NSE commenced operations in November 1994, while operations in the Derivatives segment commenced in June 2000.

[edit] Innovations
NSE has remained in the forefront of modernization of India's capital and financial markets, and its pioneering efforts include:

Being the first national, anonymous, electronic limit order book (LOB) exchange to trade securities in India. Since the success of the NSE, existent market and new market structures have followed the "NSE" model. Setting up the first clearing corporation "National Securities Clearing Corporation Ltd." in India. NSCCL was a landmark in providing innovation on all spot equity market (and later, derivatives market) trades in India. Co-promoting and setting up of National Securities Depository Limited, first depository in India [1]. Setting up of S&P CNX Nifty.

NSE pioneered commencement of Internet Trading in February 2000, which led to the wide popularization of the NSE in the broker community. Being the first exchange that, in 1996, proposed exchange traded derivatives, particularly on an equity index, in India. After four years of policy and regulatory debate and formulation, the NSE was permitted to start trading equity derivatives Being the first and the only exchange to trade GOLD ETFs (exchange traded funds) in India. NSE has also launched the NSE-CNBC-TV18 media centre in association with CNBC-TV18. NSE.IT Limited, setup in 1999 , is a 100% subsidiary of the National Stock Exchange of India. A Vertical Specialist Enterprise, NSE.IT offers end-to-end Information Technology (IT) products, solutions and services.

[edit] Markets
Currently, NSE has the following major segments of the capital market:

Equity Futures and Options Retail Debt Market Wholesale Debt Market Currency futures MUTUAL FUND STOCKS LENDING & BROWING

August 2008 Currency derivatives were introduced in India with the launch of Currency Futures in USD INR by NSE. Currently it has also launched currency futures in EURO, POUND & YEN. Interest Rate Futures was introduced for the first time in India by NSE on 31 August 2009, exactly after one year of the launch of Currency Futures. NSE became the first stock exchange to get approval for Interest rate futures as recommended by SEBI-RBI committee, on 31 August 2009, a futures contract based on 7% 10 Year GOI bond (NOTIONAL) was launched with quarterly maturities. [2]

[edit] Hours
NSE's normal trading sessions are conducted from 9:00 am India Time to 3:30 pm India Time on all days of the week except Saturdays, Sundays and Official Holidays declared by the Exchange (or by the Government of India) in advance.[8] The exchange, in association with BSE (Bombay Stock Exchange Ltd.), is thinking of revising its timings from 9.00 am India Time to 5.00 pm India Time. There were System Testing going on and opinions, suggestions or feedback on the New Proposed Timings are being invited from the brokers across India. And finally on 18

November 2009 regulator decided to drop their ambitious goal of longest Asia Trading Hours due to strong opposition from its members. On 16 December 2009, NSE announced that it would pre-pone the market opening at 9am from 18 December 2009. So NSE trading hours will be from 9:00 am till 3:30 pm India Time. However, on 17 December 2009, after strong protests from brokers, the Exchange decided to postpone the change in trading hours till 4 Jan 2010. NSE new market timing from 4 Jan 2010 is 9:00 am till 3:30 pm India Time. National Stock Exchange A+ A-

National Stock Exchange of India (NSE) is India's largest Stock Exchange & World's third largest Stock Exchange in terms of transactions. Located in Mumbai, NSE was promoted by leading Financial Institutions at the behest of the Government of India, and was incorporated in November 1992 as a tax-paying company. In April 1993, NSE was recognized as a Stock exchange under the Securities Contracts (Regulation) Act-1956. NSE commenced operations in the Wholesale Debt Market (WDM) segment in June 1994. Capital Market (Equities) segment of the NSE commenced operations in November 1994, while operations in the Derivatives segment commenced in June 2000. NSE has played a catalytic role in reforming Indian securities market in terms of microstructure, market practices and trading volumes. NSE has set up its trading system as a nationwide, fully automated screen based trading system. It has written for itself the mandate to create World-class Stock Exchange and use it as an instrument of change for the industry as a whole through competitive pressure. NSE is set up on a demutualised model wherein the ownership, management and trading rights are in the hands of three different sets of people. This has completely eliminated any conflict of interest. NSE was set up with the objectives of:

Establishing nationwide trading facility for all types of securities Ensuring equal access to investors all over the country through an appropriate telecommunication network Providing fair, efficient & transparent securities market using electronic trading system Enabling shorter settlement cycles and book entry settlements Meeting International benchmarks and standards

Within a very short span of time, NSE has been able to achieve its objectives for which it was set up. Indian Capital Markets are a far cry from what they were 12 years back in terms of market practices, infrastructure, technology, risk management, clearing and settlement and investor service. To ensure continuity of business, NSE has built a full fledged BCP site operational for last 7 years.

NSE's markets NSE provides a fully automated screen-based trading system with national reach in the following major market segments:

Equity OR Capital Markets {NSE's market share is over 65%} Futures & Options OR Derivatives Market {NSE's market share over 99.5%} Wholesale Debt Market (WDM) Mutual Funds (MF) Initial Public Offerings (IPO)

What are the IT initiatives of NSE in the last one year? NSE believes that technology shall continue to provide necessary impetus for any organisation to retain its competitive edge, ensure timeliness & satisfaction in customer service. Being fully dependant on Information Technology, NSE has stressed on innovation and sustained investment in technology on a continual basis to ensure customer satisfaction, improvement in services which automatically helps in sustaining business and remain ahead of competition. As a policy, NSE looks to improve the quality of Services to its customers. Projects are not initiated based on a business model to reap profits but from a strategic perspective of better productivity, Value-adds & features, improving efficiency, reducing operational costs, compliance, operational transparency etc for the customers, investors and to the entire Indian Securities Industry. Some of the projects taken by NSE last year are as follows:1. 2. 3. 4. Trading System Capacity enhancement Re-engineering of Online Position Monitoring (OPMS) Augmentation of Data Warehouse (DWH) STP Central Hub

What was the objective, business benefits that the company derived and beneficiaries of the implementation of Trading System Capacity enhancement? Project Objective NSE's Capital Market Trading system was operational on two machine split architecture using Fault Tolerant mainframes and geared to handle 3 million trades. However, the CM segment had started to experience trades nearing 3 Million trades which form a threshold. Based on the trends & expected volumes, growth in the medium term is more than thrice the current trading volume, i.e. about 10 Million transactions per day. However with the then existing 2-machine split architecture, it was required to improve the trading system transaction handling capacity. The 3-machine split architecture project was thus taken up to enhance the load handling capacity of the system by introducing a 3-way split Hardware, Application optimisation and improving the processes for achieving market volume of around 6 million transactions per day. Project was completed as per schedule & is currently operational since last 1 year.

Business Benefits 1. System scaled on 3 machines with distribution of users and securities with complete transparency to market participants. 2. System witnessed 3 million trades with faster response time to members at significantly lower system resource utilisation level. 3. Scalability to handle higher volumes (3 million to 6 million transactions per day). Beneficiaries Trading Members have experienced a faster response time. The trading system is able to handle higher volume of transactions which translates into higher turnover. It therefore directly translates into more opportunities and growth for the Entire Indian Securities market. What was the objective, business benefits that the company derived and beneficiaries of the implementation of re-engineering of Online Position Monitoring (OPMS)? Project Objective OPMS is On-line Position Monitoring and Risk Management system for the Capital Market segment of the National Stock Exchange of India Limited. It tracks positions of trading members from Turnover and Exposure limits with a view of identifying and preventing potential settlement related issues. The positions are monitored on an on-line basis and the system provides for auto disablement of the violating member on the trading system. Based on the volumes, it is expected that the current trading levels of about 3 million trades per day may rise to the new heights of 10 million trades per day in the near future. It was therefore necessary to initiate was to reengineer OPMS system without imposing any major cost associated with architectural overhauling. Another key objective was to scale the violation detection mechanism by a mammoth factor from around 300 violation checks per second to handle more than 4000 violations per second. Other major objectives and the goals include:

Real-time position computation and violation detection Ability to handle high load of over one million client positions Management of information for positions & risk values about each trading member Information structure based on a tree of security, settlement, trading member Handle on-line collateral and securities early pay-in Total fault tolerance with minimum downtime Achieve 4000 violation checks per second

Business Benefits

1. Effective and efficient Risk Management- Violation turnover reduced from few seconds to few milliseconds & 99.96% trades processed for Risk Management within a second of occurrence. 2. Better utilisation of Resources- Peak capacity of trades handling capacity enhanced to 10 million trades & Average CPU utilisation reduced from 70% to 20%. 3. Linearly scalable Beneficiaries Trading Members risk management has significantly improved. Trading members have benefited due to this initiative. What was the objective, business benefits that the company derived and beneficiaries of the implementation Augmentation of Data Warehouse (DWH)? Project Objective NSE has a matured data warehouse application extensively used for analysis, reporting and investigative purposes. The project was to enhance and upgrade existing data warehouse infrastructure in terms of:

Migrating to a higher capacity server and storage hardware Migrating database from Oracle 8 to Oracle 9i Upgrade existing ETL solution consisting of a separate extraction solution and transformation cum loading solution into a complete and unified ETL tool

Business Benefits 1. 2. 3. 4. Response time & query performance improved dramatically by about 100%. Extraction and loading time has reduced by almost 8-9 times. Timely, efficient reporting. Reduced lead time in providing data to Regulator. New features of Oracle 9i like Ranking, enhanced analytic functions have contributed enormously to efficiency aspect of the data warehouse usage.

Beneficiaries Benefit accrued to NSE as an organisation due to the extensive usage of DWH. What was the objective, business benefits that the company derived and beneficiaries of the implementation STP Central Hub? Project Objective During a typical day at an institutional fund house, details of trade confirmations executed in the day are sent out to the Custodian for effecting trade settlements. The Custodian also receives details of the executed trade from the broker of the fund house, for cross-verification of the trade data. Upon verification, if it is found that the trade details do not match the instruction documents sent across by the fund house and the broker there is a delay in effecting such settlements. This is a global phenomenon that is a

concern for all the major financial institutions. Studies have shown that around 15% of global trade failures result from unmatched trade data, which in monetary terms is upwards of Billions of Dollars, a steep price pay for the lack of an efficient processing framework. Straight Through Processing (STP) framework seeks to provide seamless data flow both within the enterprise as well as across the market without any manual intervention using ISO 15022 messaging standards. In India, inspite of SEBI making STP mandatory, market participants were not able to fully adapt the STP framework into their operations as the STP services provided by various providers were not interoperable. This meant that messages destined for market participants registered across the service providers could not be achieved. One of the options was to ensure that each of the STP provider "talked" to other STP providers, but this meant a mathematical explosion in terms of number of interconnects in case of increasing number of service providers. Recognising that the success of the STP is crucial to make a move towards T+1 settlement cycle, NSE took up the challenge of setting up a Central Hub to resolve interoperability amongst various STP Service Providers. After developing the application software, the STP Central Hub was put for operational testing from end of March 2004 to route the messages between Service Providers. STP Central Hub has ensured seamless operations of message processing. After the initial testing and stabilization period, SEBI has mandated use of STP system for all institutional trades. SEBI endeavoured to shorten the settlement cycle and has been successful in reducing the same from T+5 to T+2. It has now set a target for achieving T+1 settlement in Indian Securities Market. T+1 settlement cycle has not been achieved anywhere in the world and India is the first country to successfully implement STP effectively for all the market intermediaries. NSE through its strength in technology innovations has made it possible for the integration of all STP service providers using heterogeneous protocols within their own system so as to provide the necessary impetus to the process Business Benefits 1. Improved efficiency, reduction of manual activities leading to higher accuracy of trade execution and settlement. 2. Reduced operational risk by automating the process from execution through to settlement. 3. Reduction in operational cost by sending data electronically. 4. Transparency & improved customer service with detailed reports about delivery and failure of messages are available instantaneously, on an on-line basis. 5. Reduced settlement cycle to facilitate T+1 settlement. Beneficiaries Entire Indian Securities Industry has been the beneficiary of the STP Central Hub initiative. It is the only STP Central Hub operational since the last few years. This move has helped for faster clearing and settlement in Indian Securities Industry and help

achieve 'T+1' environment in India. India's profile in International markets was enhanced which will help in attracting further foreign investments.